When investing, select a fund wisely

Investors should avoid jumping from their current funds into those that have outperformed lately, advises Arnav Pandya, a certified financial planner.Illustration: Uttam Ghosh/Rediff.com

On August 28, the BSE Sensex closed at a lifetime high of 38,896. Year-to-date it is up 8.39 per cent.

The midcap and smallcap segments, which were market favourites until last year, have underperformed year-to-date.

The S&P BSE Midcap Index is down 9.72 per cent while the S&P BSE Smallcap is down 14.49 per cent.

Meanwhile, there are ominous signs emanating from abroad.

Currencies of various emerging markets like Turkey and Argentina have depreciated sharply against the US dollar.

India's GDP growth rate for the first quarter of 2018-2019 was high at 8.2 per cent.

But the rupee has depreciated around 11 per cent YTD against the dollar and with crude oil prices trading at high levels, the current account deficit widened to 2.4 per cent of GDP.

On the positive side, there were indications in the first quarter results that earnings are poised for a recovery.

In recent days, large-cap indices like the Sensex too have witnessed a lot of volatility.

With a crisis brewing in emerging markets and the country set to enter election mode -- we have state elections first followed by the general election next year -- many market experts expect the current bout of volatility to continue for the next year.

Here are a few danger signals that mutual fund investors need to watch out for in the late stages of the current market rally.

Narrowing rally

Towards the end of a long bull run in equities, the market rally tends to get narrow.

The market is driven by only a few stocks.

This is what we have witnessed in the stock markets in recent times.

The recent large-cap rally was driven by less than 10 stocks.

Funds that were invested in these stocks have done well, while those that did not pick these stocks have lagged behind.

If your large-cap fund is currently lagging behind its benchmark, do not exit it and switch to a fund that is outperforming.

The holdings that the outperforming funds benefited from have already rallied.

For future gains, these funds too will have to invest in stocks that are underperforming currently.

So, the outperformance of these funds could end just when you enter them.

Instead, give the fund that you are in more time.

If it is has a sound long-term track record, it will catch up with its peers in due course.

Entering the funds that are outperforming currently entails another risk.

In case of a correction, it may be the sharpest in those stocks and sectors that have run up the most to compensate for the higher growth they have witnessed in the past.

Your portfolio could end up being hurt even more by being invested in these outperforming funds.

Closed-end new fund offers

Investor participation in equity funds tends to go up when there is a boom in equities.

We have seen the asset under management (AUM) of the mutual fund industry swell in the past few years.

While overall industry AUM has risen from Rs 7.59 trillion in August 2013 to Rs 25.22 trillion in August 2018, equity AUM is up from Rs 1.59 trillion to Rs 10.12 trillion over the same period.

In buoyant times, the mutual fund industry launches a slew of new fund offers (NFOs) to take advantage of positive sentiment and gather more funds from investors.